One of my favorite factors in all of the psychology of money has to do with
something called the pain of paying, and here is the idea.
Imagine that you go to dinner, it's an expensive dinner, it's a good dinner.
At the end of the dinner you are paying, and you can pay either with the cash or
with credit card. Ask yourself which one would feel worse.
Which one would you feel a bit more ting, a bit more unpleasantness?
It would kind of diminish they joy of the meal.
Eh, basically everybody when they ask this question say the cash would feel worse
than the credit card. Now why?
Why does the cash feel, feel so different? You know how much the meal would cost.
This is not surprise. You see the prices on the menu.
But something aout the cash feels differently.
Where is it coming from? And there is this notion of the pain of
paying. We'd say that the agony of parting with
our money has to do with the saliency of do we see this money going away, and it
has to do with the timing of whether the money is going away at the same time that
we're consuming. So imagine the following example.
Imagine that I own the restaurant, and I learned over time that people basically
eat 50 bites and pay $50. That's what everybody does, or more or
less everybody does. And they came to you and they said it
because I like you so much, I'm going to give you a great discount.
It's going to be 50 cents per bite. I'll only charge you 50 cents per bite,
and not only that, I'll only charge you for the bites you eat.
So I'll serve you your dish I will stand back, I will open my little eh, notebook
and every time you will take a bite, I will write a v in this is to indicate how
man bites you took and at the end of the meal, I will charge you 50 cents only for
the bites that you took. Now ask yourself, is this going to be a
financially efficient meal? Of course.
You start at 50 cents per bite and only for the bites You eat.
But how much fun will that meal be? Probably will be quite terrible.
In fact, in my Ph.D. Seminar not to long ago I tried that.
I usually bring lunch for the students in the Ph.D.
Seminar, and on that particular day I told them that I'm going to charge them 25
cents per bite. I gave, I brought pizza the same day.
And you know what? Their bites where so huge.
It was awful. I could basically stuff their face to get,
the maximum amount of bite. And, you know, they were really good,
these are PHD students. They are really, very well versed in
getting free food and eating very quickly. But at the end of the day, they did not
enjoy. Sure, they paid a little less, but the
misery was very, was very high. Here's another way to think about it.
Imagine you're going for a cruise. It's a cruise to Alaska.
It's a beautiful cruise and you have two ways of paying.
You can either pay three months in advance before you go on the cruise or you can pay
the moment you get off the boat. Which one of those is the economically
efficient way to pay? Of course the moment you get off the boat.
You keep the money for longer, you can invest it and so on.
But ask yourself how would you feel during the cruise if you know that the end of the
cruise you have to pay all this amount? Ask yourself, how would you feel in the
last day of the cruise knowing that tomorrow you're going to be parting with
all this money? You would probably spend the whole day in
the buffet trying to advertise your investment, trying to get as much as you
can back. And then, of course, you have to pay a
trainer or go to the gym, or do something else to try and get rid of this extra
weight. So what's interesting here is that we have
this notion of the pain of paying and what the pain of paying does is it adds a moral
tax on to our consumption and because of that it changes how we feel about payment.
And what's also interesting about this small tax.
It's about saliency. It's about how we feel about these
payments, how mu, how a much attention we give to it.
How much do we notice it? And because of that it can change how we
enjoy the experience. So think about the following question.
Are there cases in which you would like to increase the pain of paying?
And all the cases in which you like to decrease the pain of paying.
So think about this for, for a minute or so.
Here are a couple of ways to think about the pain of paying and is it good or is it
bad. So for example, I think that if we go
around our consumption day by day, we might want to feel more pain of pain.
We might say to ourself. You know what them spending too much money
and all kind of things. Let me feel more pain of pain.
Let me switch from credit cards, which disassociate the consumption from the
timing of the payment to cash. Or if I can't go all the way to cash, we
will go to debit card, which give you some sens of paying at the moment.
Maybe I'll sign up for automatic notification.
That, every time I use my debit card, it would let me know that I just spend some
money, and that would increase, the pain of paying.
And control my spending, to some degree. You can also think about the difference
between paying for gasoline, and paying for electricity.
When we pay for gasoline, we stand in the gas station, we put the thing in, we press
the button and we see this running around. There's an incredibly high pain of paying
feeling to it because we see the amount of money running.
You could imagine, by the way, an even worse version.
You could imagine that filling the gas station would take, would be
instantaneously and we'd know amount of money.
But then the gas company will have a little meter running in your car.
And as you're driving you see how many cents are being taken away from you bank
account. And every time you press fast on the
accelerator it will go a little faster it will maximize, the pain of paying.
But with gas, even the way it is now,with petrol , we have this increased high pain
of paying. We see the amount of money.
We buy a lot of it every time. We see it running around.
Think about the electricity. Electricity, we have no meter in the home,
it's usually outside. We don't see it progressing.
It's automatically taken from our checking account a month and something later, after
we've finished consuming it. No pain of paying.
Now maybe we should have brought some pain of paying into it.
For example, what if we put the meter in the middle of the living room?
Right? Now you would take it.
Or even better, you know, there used to be this English system, where for heating a
home you would put coins into the system and it would heat your house just for a
while. Imagine your air conditioning and heater
was working like this. Every time you wanted heat or AC you would
put the money in. And it would, eh, run until you choose and
then you had to put more money in, and now the pain of paying would increase further
and your house would probably not be as comfortable as you want.
Now, there's some cases we might want to decease the pain of paying.
Imagine you go on vacation. And you go on vacation, it's expensive
place, and you know, you spend lots of money on it, but in the evening you want
this. Particular drink martini and it's
expensive. Now if you feel the pain of paying and you
have to pay extra for the martini you might decide not to have that martini but
is this the right thing. Well, if you paid for a prepaid vacation
that includes everything. You might spend, in absolute terms, more
money. But you would not have to think about all
of these small components. And by not having to think about all of
these small components, you might actually enjoy your vacation to a high degree.
So you can imagine how prepaying for something, or paying for an all inclusive
vacation, or paying to reduce the pain of paying could actually get you to do
something that you want to do, but have a hard time doing.
And here's one last example of, the agony of pain of paying, and how to reduce it.
And this has to do with what is an ideal gift.
Think about it. What is an ideal gift?
And I don't mean that you could say, you know, shoes or a backpack or something
like that. What are the characteristics of an ideal
gift? And one thing about an ideal gift is that
it removes the pain of paying from other people.
So I'm sure all of you have things that you want but don't feel right about
geting. And those are exactly the things that are
great gifts. Because you want it and this pain of
paying is preventing you from doing it. So imagine, for example, that you walk
down the street, and, you, at the window of a store you see a hat.
And you put on the hat and it's beautiful. It's wonderful, it's the right color and
size. Beautiful shape, really interesting.
But then you take it off and you look at the price and you say to yourself, I just
can't imagine paying this amount of money for a hat.
Who really buys hat? You put it back.
You go home, and you find out that your significant other bought the same exact
hat for you, from your joint checking account.
What do you do? Do you say, honey thank you very much, I
thought about it, I considered it, but I decided it was not worth it, please take
the hat and return it. Of course not, you would be incredibly
grateful. Why?
Because your significant other has just taken this pain of paying out of the
transaction, giving you only the benefits. And that's by the way, one of the
characteristics of a good, of a good gift. So going back in general to the pain of
paying it means that payment have the opportunity cost, right, you giving up
something when you buying something which we don't always notice but is a part of
the[UNKNOWN]. It has hassle component, taking cash,
taking credit cards and so on. But it also has a component of the pain of
paying, of a moral tax, of some guilt, it is associated with the payment, and
different methods of payment could create different amount of guilt and different
timing of payment would create different guilt.
And so it we prepaid for vacation, not so much guilt.
If we pay for vacation or for meal for every bite, maximum guilt.
If we pay after the fact, like in credit cards, not so much guilt.
In addition to the timing, the method of payment also matters.
If you go to a casino, and you take $1,000 and you transition them to chips, now
you've basically in your mind taken all this amount of money and allocated them.
To be spend in the, in the casino. Not so much pain of paying is involved now
when you spend it. Or if I gave you $1,000, good for an
online store for ten years, the money would be associated with that particular
purchase. There would be no pain of paying and you
would find it incredibly easy. To, to spend on that, on that category.
There was a very interesting case about the pain of paying that happened many
years ago with America Online. America Online, for a long time, used to
charge people by the hour. In fact, they had two packages.
You could pay $19.95 for 20 hours. And then plus $2.95 for every additional
hour. Or you can get a smaller package of $9.95
for five hours, plus $2.95 for each additional hour.
But most people took the 20 hours for $19.95, and they paid additional.
And then, at some point, in 1996, at the end of 1996.
Aol decided. To move to a membership in which there
would be no charge for the additional hour.
So instead of $19.95 for 20 hours plus $2.95 per hour, they moved to $19.95 for
all the amount of time that you can consume.
Now, let's assume that you're going to make this transition, from this tier
system, up to 20 hours and then each additional hour costs you, to the system
in which You can buy, you could use as much as you want.
What do you have to try an estimate? You have to try to estimate how many
people are going to start using more. That was a period that modems were around
and America Online had to decide how many more modems to have.
So they basically looked at the distribution of how many people used it
and they said that people who were using more than 20 hours.
They were constrained by the marginal cost.
So the people who used more than 20 hours would probably want to use more, maybe
another ten hours, maybe another 20 hours. These are people that were constrained by
the marginal, cost. But the people who used 19 hours were not
really constrained. They could have used another hour.
But they said, you know, maybe people who used 19 hours were a little bit
constrained because they kind of missed their calculations.
But the people who used ten hours. Those people clearly didn't have any more
demand. They could have used another ten hours.
And don't feel and don't pay for it. So they look at this distribution, they
looked at the number of people who spend more than 20 hours and assume that they
will use much more. The took a the people who spent 19, and
maybe 18 hours and so on and said maybe they will use a little bit more because
they got confused with the calculation in trying to keep track.
And based on that they increased their capacity by a tiny amount.
But what actually happened that night? The demand[SOUND].
Quadrupled, right? Why?
Because it wasn't just about the 20 hour. It was about the fact that you, if you
were AOL user, and I was in those days, if you're an AOL user in those days.
I guess I'm dating myself sorry for that, but if I.
If you were like me, an AOL user in those time.
You had the little clock. A little bit like the gas meter, like the
gasoline meter. That runs around and says, finished 1
hour, finished 2 hours. And even though I might never get to my 20
hours. This was an annoying feeling.
Just knowing what it is. And it's counting, and going up and up and
up, was an annoying feeling. And because of that.
Even the people who were using very little all of a sudden changed dramatically their
behavior and started using much more. Now to AOL's sad, reality, they were
completely unprepared for that. So that night they had to deal with all
kinds of access demand. And they had to hire lines and get all the
small operators to, to help them out and, these small operators were only happy to
you know, stick it them and overcharge them for this, for this particular
privilege. But this was a case in which AOL should
have been prepared, right? Aol made the rational calculation as if
people, what was stopping them was only the marginal cost.
But if you think about people as what's stopping them is both the rational cost,
the increased marginal cost, but also the pain of paying.
You would make very different predictions about what's right and wrong.
And very different predictions about how your market would look like before such a
change and after such a change.